Return on assets Estonia 2017 OECD economic survey overview

ASSESSMENT AND RECOMMENDATIONS OECD ECONOMIC SURVEYS: ESTONIA © OECD 2017 23 low, expected increases in labour market participation will be accompanied by an increase in the unemployment rate over the projection period. Household spending will decelerate as inflation resumes. Consumer prices will increase by more than 3 in 2017 due to rising commodities, oil and energy prices, and large rises in excise duties on alcohol, tobacco and fuels with an estimated impact of 0.9 and 1 percentage point on inflation in 2017 and 2018, respectively. Nevertheless, private consumption will remain strong, supported by rising wages and planned cuts in the personal income tax. Estonia’s growth prospects are very sensitive to developments in its main trading partners and in the euro area, implying both downside and upside risks. Brexit may have only a small direct impact on the Estonian economy as trade links with the United Kingdom are limited, but may affect it via its effects on trade in the Baltic Sea region. Domestic negative risks include deeper divergence between wages and productivity growth. Conversely, a higher level of return migration or better-than-expected integration of disabled and older workers in the labour market would relax labour supply constraints and wage pressures. Risks to the projection also include extreme shocks, which might have large economic repercussions if they materialise Table 2. Macro-financial vulnerabilities have receded since 2007, but one of the tail risks includes capital outflows from Nordic parent banks Figure 11 and Table 2. Figure 11. Macroeconomic vulnerabilities have diminished since 2007 Deviations of indicators from their real time long-term averages 0, with the highest deviations representing the greatest potential vulnerability +1, and the lowest deviations representing the smallest potential vulnerability -1 1 1. Each aggregate macro-financial vulnerability indicator is calculated by aggregating simple average normalised individual indicators. Growth sustainability includes: capacity utilisation of the manufacturing sector, total hours worked as a proportion of the working- age population hours worked, difference between GDP growth and productivity growth productivity gap, and an indicator combining the length and strength of expansion from the previous trough growth duration. Price stability includes headline and core inflation consumer prices, and it is calculated by the following formula: absolute value of core inflation minus inflation target + headline inflation minus core inflation. External position includes: the average of unit labour cost based real effective exchange rate REER, and consumer price based REER cost competitiveness, relative prices of exported goods and services price competitiveness, current account CA balance as a percentage of GDP and net international investment position NIIP as a percentage of GDP. Net saving includes: government, household and corporate net saving, all expressed as a percentage of GDP. Financial stability includes: banks’ size as a percentage of GDP, the share of non-performing loans in total loans, external bank debt as percentage of total banks’ liabilities, and capital and reserves as a proportion of total liabilities leverage ratio. Source: OECD calculations based on OECD 2017, OECD Economic Outlook: Statistics and Projections database, June; OECD 2017, Main Economic Indicators database, June; Statistics Estonia, June; IMF, Financial Soundness Indicators database and Thomson Reuters Datastream. 1 2 http:dx.doi.org10.1787888933581144 - 1.0 - 0.5 0.0 0.5 1.0 Growth sustainability Price stability External position Net saving Financial stability

A. Aggregate indicators

- 1.0 - 0.5 0.0 0.5 1.0 Capacity utilisation Hours worked Productivity gap Growth duration Consumer prices Cost competitiveness Price competitiveness CA balance NIIP Gov. net saving Housh. net saving Corp. net saving Banks size Non-performing loans External bank debt Leverage ratio

B. Individual indicators

Q1 2017 or latest data available 2007 Long-term average ASSESSMENT AND RECOMMENDATIONS OECD ECONOMIC SURVEYS: ESTONIA © OECD 2017 24 Fiscal and social policies could better sustain inclusive growth Using fiscal space for a more inclusive growth Fiscal policy has been tight over past years, despite economic slack. Estonia has the lowest gross public debt relative to GDP in the OECD around 13, a rough budget balance since 2010, and an estimated structural budget surplus since 2009 Figure 12. The government plans a structural deficit of 0.5 in 2018, 2019 and 0.3 of GDP in 2020. The budgetary plans include broad changes in the tax system and increased spending on infrastructure, health care, education and family benefits Box 1. The Fiscal Council and the Central Bank have raised concerns about a possible deviation of the deficit from current plans and questioned the expected increase in tax revenues. Given the current favourable borrowing conditions and the need for growth-enhancing policies, the planned easing of fiscal policy over 2017-20 is appropriate. Fiscal room should be used to increase long-term growth potential, notably for measures that increase labour supply and productivity growth. As detailed below, more needs to be done to support innovative activities in domestic firms, improving access to lifelong education, and fostering labour market participation of mothers, while reducing labour taxation. In addition, public spending should be used to reinforce social protection, which does not adequately protect the most vulnerable against poverty, notably by activating all individuals with some work capacity. Such fiscal initiatives should rely on ex ante evaluation OECD, 2016a. Cost and benefit analyses have not been systematically carried out for the infrastructure projects planned for 2018-20, and, given the already considerable levels of investment in road and rail transport, it is unlikely that such additional projects will have high positive economic returns. Furthermore, they will inevitably induce extra maintenance costs in the longer run. Ex ante evaluation should ideally be carried out by an independent advisory body tasked with reviewing long-term economic challenges and identifying priorities and synergies, as is done in a number of OECD countries including the Netherlands and Australia. A well-designed institution can improve the quality of the decision process and contribute to evidence-based policymaking Banks, 2015. There is no unique institution in charge of undertaking or commissioning the necessary research and analysis to identify the most promising growth-enhancing policies for Estonia. The authorities are considering different options to comply with the recent recommendation of the EU Council to establish productivity boards. While the national context is central in determining the optimal design, mandate, mission and governance of pro-productivity institutions, a recent OECD analysis shows that such institutions should be given sufficient resources, skills, transparency and procedural accountability to fulfil their tasks. It should consider both supply-side and demand-side policies including those proposed by the government and have policy evaluation functions Renda and Dougherty, 2017. Table 2. Possible shocks to the Estonian economy Vulnerability Possible outcome Increase in geopolitical tensions This could trigger an international financial crisis with difficult-to-project consequences for confidence and activity in Estonia. Banking crisis Sudden withdrawal of capital by Nordic parent banks could lead to a sharp credit squeeze.